OneSpan Inc. (OSPN) Q3 2021 Earnings Report, Transcript and Summary

Good afternoon. Thank you for standing by and welcome to the OneSpan Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a Question-And-Answer Session. [Operator Instructions] Thank you. Please note today’s call is being recorded.. I would now like to hand the conference over to your first speaker today, Joe Maxa, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan Third Quarter 2021 Earnings Conference Call. This call is being webcast and can be accessed on the Investor Relations section of OneSpan’s website at investors.onespan.com. Joining me on the call today are, Steven Worth, OneSpan’s Interim Chief Executive Officer, and Jan Kees van Gaalen, our Interim Chief Financial Officer. This afternoon, after market close, OneSpan issued a press release announcing results for our third quarter 2021. To access a copy of the press release and other investor information, including a presentation reflecting our third quarter financial results, please visit our website. Following our prepared comments today, we will open the call for questions. Please note that statements made during this conference call that relate to future plans, events or performance, including the outlook for full year 2021 are forward-looking statements. These statements use words such as believes, anticipates, plans, expects, projects and similar words, and these statements involve risks and uncertainties, and are based on current assumptions. Consequently, actual results could differ materially from the expectations expressed in these forward-looking statements. I direct your attention to today’s press release and the company’s Form 10-K and Form 10-Q filings with the U.S. Securities and Exchange Commission for a discussion of such risks and uncertainties. Also note that certain financial measures that may be discussed on this call are expressed on a non-GAAP basis and have been adjusted from a related GAAP financial measure. We have provided an explanation for and reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in the earnings press release. In addition, please note that the date of this call is November 2, 2021. Any forward-looking statements and related assumptions are made as of this date. Except as required by law, we undertake no obligation to update these statements as a result of new information or future events or for any other reason. With that, I will turn the call over to Steven.

Thanks very much, Joe, and good afternoon, everyone. Thank you for joining us on today’s call. Before we get into our third quarter results, I’d like to welcome Jan Kees van Gaalen to OnSpan. Jan Kees joined the company as Interim CFO and Treasurer last month. He brings a wealth of accounting, finance and consulting experience including fifteen years in Chief Financial Officer roles where he was instrumental in implementing significant cost saving efforts. We believe Jan Kees’ skill set matches our needs well as we look to streamline and optimize our operations in the coming months. Our Board would also like to share its update on the CEO search, which began after the departure of our former CEO in August. The search has emphasized relevant skill sets including demonstrated leadership in growth strategies, operational efficiencies and transformational activities. That process continues to advance and the Board will share more information as the process unfolds. Now I’d like to provide you with an update on our strategic action plan in progress. Over the last three months, we have been hard at work evaluating our product portfolio, the markets we serve, our investments and our operations in order to identify ways to best leverage our strengths, enhance our growth profile, reduce cost and drive improved performance. We have made significant progress in formulating our action plan by leveraging a combination of internal experts, board members, industry analysts and FTI, a leading global business transformation consulting firm. We are working diligently to identify and take action on initial cost reduction opportunities that will provide a range of expected savings before year end. We are also making progress on forming an action plan to accelerate our recurring revenue growth. We will give you more details on this strategic action plan in the coming months and we expect to host an Investor Day in early Q2. We have great confidence in the markets we serve where our products are uniquely positioned to win and provide us opportunities to generate additional growth. Our core offerings are performing well and we believe we have significant opportunity to increase long-term recurring revenue growth. We will focus on our fastest growing product categories where we can capitalize on our competitive position and expand our market search. For example, we have had extremely effective growth in e-signature subscription revenue this year as we are well positioned in that market. With that, I’ll turn to our third quarter results, which demonstrated our ability to execute through a management transition, our internal review and hardware supply chain issues, which Jan Kees will discuss in a few minutes. We had a strong quarter of recurring revenue growth driven by both our e-signature and mobile security solutions. For the quarter, recurring revenue grew 38% year-over-year with e-signature subscription revenue growing 45% and mobile security term license revenue growing even faster. We believe demand for these solutions will continue well into the future based on our internal forecast, our customer feedback and industry analysts. Demand for our mobile security solutions is driven by the increasing need to improve the user experience and to mitigate the risk of fraud. Mobile banking and other remote financial services applications have been widely adopted around the globe. Yet a recent study found 70% of the top 400 mobile finance-related apps have security vulnerabilities. Our market-leading mobile security solutions are having success in part because they are designed to improve the user experience and mitigate that risk of fraud. Demand for e-signatures accelerated during the pandemic. It is moderated recently yet remains strong. Our volumes continue to increase and indications such as this will continue in the coming years based on growing opportunities in our current use cases, in new use cases and in new geographies. For example, our investments in e-signature add-on offerings such as virtual room and identity verification are gaining traction. Virtual room provides businesses with the ability to conduct remote mediated transactions that combine digital and human interaction to improve the customer experience. Two recent examples include, a customer serving the legal community that launched a product providing a complete digital process for verifying the identity of individuals. They are using our virtual room because it provides a secure encrypted online video conference service where the lawyers and business professionals are able to meet virtually and electronically sign documents with verified participants. A second example is a banking customer of ours that is launching a closing room product supported by our technology to drive their commercial real estate business. This will allow lenders and borrowers to meet virtually to complete a mortgage transaction using e-signatures and virtual room replacing the more costly and time consuming in-person meetings that utilize paper-based processes. The bank intends to expand this offering to other high value lending use cases. We also won several contracts that utilize our recently integrated identity verification and e-signature capabilities. Some of the use cases include remote bank account openings, tighter insurance agreements and automobile financing. I’ll now pass the call over to Jan Kees to take you through our financial results, and then I’ll come back to provide additional comments along with an update on our outlook before opening the call to questions. Jan Kees?

Thank you, Steven. I am excited to be here at OneSpan and look forward to contributing to the team as we take the next steps in our strategic transformation. Jumping into the quarterly results, annual recurring at the end of Q3 was $119 million, representing a growth rate of 24%, compared to the prior year period. ARR, specific to subscription and term-based contracts, which account for approximately two-thirds of our total ARR increased more than 40%. Dollar-based net expansion rate or DBNE which we define as the year-over-year growth within ARR from existing customers, was 115% in the third quarter. As mentioned last quarter, it was impacted in part by a handful of e-signature based, pandemic-related customer contracts, which declined in size year-over-year following a reduction in North American federal government programs related to the CARES Act. Now turning to recurring revenues. Subscription revenue grew 37% year-over-year to $10 million, primarily driven by strength in the e-signature solutions and an increased contribution from cloud authentication. Term-based software license revenue more than tripled straight, mobile security and service software accounted for the majority of their year-over-year growth and maintenance revenue grew 3% to $13 million. We are expecting modest full year 2021 maintenance revenue growth as our business model continues to transition towards subscription and term-based software licenses. Total recurring revenue increased 38% year-over-year to a record $31 million in the third quarter of 2021 and accounted for 89% of software and services revenue. In the year ago quarter, recurring revenue accounted for 74% of software and services revenue. Total software and services revenue grew 16% to $34 million. Hardware revenue was impacted by shipping issues within our supply chain and declined 17% to $18 million during the quarter. We have been proactively addressing our supply chain and recently brought a new European manufacturer as to full credibility during the quarter. We currently expect hardware revenue to improve sequentially in the fourth quarter. Total company revenue increased 2% to $52 million. Gross margin in the third quarter of 2021 was 72% compared to 70% in the third quarter of 2020. The increase in gross margin is primarily attributed to product mix with software and services accounting for 66% of total revenue as compared to 58% in the year ago quarter and the favorable product mix within hardware. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation, amortization, long-term incentive compensation and non-recurring items was $2 million in the third quarter of 2021. This compares to $3 million in the third quarter of 2020. Our GAAP loss per share was $0.02 in the third quarter of 2021, compared to $0.04 per share in the third quarter of 2020. Non-GAAP earnings per share, which excludes long-term incentive compensation, amortization, non-recurring items and the impact of tax adjustments was negative $0.03 in the third quarter of 2021, compared to $0.03 in the same quarter last year. We ended the third quarter with $98 million in cash, cash equivalents and short-term investments as compared to $115 at the end of 2020 and $109 million at the end of last quarter. During the quarter, we used $4.6 million to repurchase approximately 231,000 shares of common stock. Geographically, we continued to benefit from strong revenue growth in the Americas region, which grew 43% year-over-year in the quarter. We also had modest growth in the Asia Pac region. In EMEA, our largest markets, we continued to see headwinds related to our transition to recurring software revenue models, which was exacerbated this quarter by the hardware supply chain issues mentioned previously. Year-to-date, the Americas region grew 33% and accounted for 33% of revenue. Asia Pac declined 15% and accounted for 20% of revenue and EMEA declined 17% and accounted for 48% of revenue. I will now turn the meeting back to Steven.

Thanks, Jan Kees. As you can see from our strong third quarter results, demand for our solutions is robust and we expect this to carry through into the fourth quarter. As such, we are updating our guidance to raise the midpoint of our expectations. For the full year 2021, we currently expect total revenue to be in the range of $209 million to $213 million, as compared to our prior guidance range of $205 million to $215 million. Recurring revenue to be in the range of $118 million to $120 million as compared to our prior guidance range of $115 million to $120 million, ARR growth to be in the range of 18% to 20% as compared to our prior guidance range of 17% to 20%, and adjusted EBITDA to be in the range of negative $6 million to negative $8 million as compared to our prior guidance of negative $12 million to negative $15 million. We are happy with our team’s execution in the third quarter and are committed to continue delivering solid business performance, while we progress in forming our action plan to enhance long-term shareholder value. And with that, Jan Kees and I will be happy to take your questions. Operator?

[Operator Instructions] Our first question comes from Catherine Trebnick from Colliers Security. Catherine, please go ahead.

Hi. Nice quarter. Now I am kind of complex or ask you why you didn’t give your first phase of cost-cutting as part of the go forward initiative? And can you give me a back on why you are waiting until the end of the year?

Well, it is November. So we are pretty close, I would say, we are working on the deep dive analysis of rich items to talk to about first, because some items are independent in the nature of displaying good business decisions and other items are directly connected to our final strategic decisions and so there are a few layers of complexity that we are going to work through in the next 30 to 60 days.

Okay. And then, the follow-up question is, the ARR you are back 18% to 20% growth. Which components of that are you seeing as better growth drivers?

Certainly, e-signature and mobile security are real growth drivers there. They account for approximately two-thirds of our recurring revenue. And then, the balance is really that major piece that’s largely driven by historical perpetual license sales and that maintenance piece is a – addressed if you will on the overall growth rate.

Alright. Thanks. I appreciate the time.

Sure. Thank you.

Our next question comes from Gray Powell from BTIG. Gray, please go ahead.

Great. Thanks for taking the question and congratulations on the good numbers. So, yes, on the – yes absolutely. So, net ARR – net new ARR additions in Q3 doubled off of the pace of Q2. Was there any sort of like catch-up in delayed deal activity in Q3 from Q2? And then, I am just trying to think like through, how should we think about seasonality into Q4? Yes. Thanks.

Yes. I would say, now in our subscription business, in our license business, that can be a little bit than subscription and there are some situations where I think end of the quarter you got that Kees still working on renewals that can lean into the beginning of the next quarter. And there was a little bit of that in Q3 this year. But overall, we’ve got other individual large churn deals that may skew things, also the term license duration can move the numbers around a bit. So we will continue to have a little bit of that type of volatilities that can be term license fund.

Okay. Great. And that actually get – leads to my next question. I just, so, on the reported revenue side, there is always a few moving parts. Just I mean, how should we think about the shift from perpetual license and multi-year term impacting headline revenue growth? Like do you feel like you are at the tail end of this transition and I know it’s early to ask about a 2022 outlook. But should we expect the headwinds that we’ve seen on the perpetual license side this year start to abate next year?

Yes, with respect to the transition from perpetual by term, we have – we think we are at the end of the journey, but we can start to see that finish line, yet, you will see that that decrease as there will be significance in 2021 over 2020. We should get to a number by the end of the year that is small enough that you won’t see as much of that transition continuing to occur in 2022. And we’ll get a spot where it’s going to be driven more on a case-by-case basis if we have report historic customers that prefer to purchase that way. The conversations that we have with them it will end up determining whether the number stays whether that at the end of the year goes to over. And then, I would say, in terms of overall term contracts, we have kicked back a little bit longer in contract or contract relation and that’s partly driven by the needs and wants of our customers and partly driven by a little bit more flexibility we have given to our sales team to entertain multi-year contracts where it makes sense in particular opportunity. I suspect that we will continue to have the same philosophy going into next year.

Got it. Okay. So it sounds like, I mean, I thought in the past that you are trending towards one year term license deals and it sounds like there was sort of a tick back up in Q3. Is that basically what you say?

That’s correct. Yes.

Okay. Perfect. Thank you very much.

We now have a question from Anja Soderstrom with Sidoti. Please go ahead.

Hey, thank you for taking my question and congratulations on the good numbers. First off I was just curious you were talking about the revenue mix impacting the gross margin and you noted that favorable product mix within hardware. Can you just elaborate on that how that product mix looks like and the margin profile to look?

Sure. So, within the overall mix, we had more of the overall revenue coming from software and services. So that is the driver to overall higher margins by a small of the equal amount. And then within the short revenue products, we also had a mix shift where this quarter we have some higher sales with some higher margin that were skewed and part of that was driven by the transportation supply chain issues mentioned where some products at the end of the quarter did not make it through the port process. And those products just happen to be SKUs with lower margin. So, we are happy to report that continues did make it up for both where process with the customers now. But that is something that we had at the end of the quarter.

Perfect. Thank you. And then in terms of the – of your go to market strategy, I mean, I know you are looking at that strategic overview now, but has anything changed there in terms of sales team or go to market?

We have made a number of changes starting last summer when our new Chief Revenue Officer took over. Those are largely behind the scenes and not public, I guess, I would say. But that continued to evolve as we are deep right now in the process of planning our 2022 go to market strategy sales conversation, budgeting all of those things are going on right now. So, I think we will have more changes to see in future.

Okay. Thank you. And then, just a last one, sort of your increased midpoint of your guidance range. So it looks like, if you achieve that for the full year, you will have a pretty strong fourth quarter. What gives you confidence in that? And what you see in the pipeline? What kind of visibility do you have?

We are confident in where we put our guidance and we will have a solid quarter. You can infer those guidance numbers that the - that will be adjusted EBITDA for Q4 will be able to spend Q3 due to seasonality and the normal factors. But yes, we were very heartened to be able to report to you that our adjusted EBITDA was not going to be as negative as projected earlier.

Okay. Great. That was all for me. Thank you.

[Operator Instructions] Our next question comes from Rudy Kessinger from D.A. Davidson. Rudy, your line is now open.

Hey guys. Thanks for taking my question and congrats on a good quarter. I guess, I am curious, as I look at the guide and kind of backing to what it implies for Q4, it looks like recurring revenue is only expected to increase by about a quarter of a million sequentially in Q4 versus Q3. Just what are the factors that went into that? Is term expected to decline sequentially or just look, what’s driving that?

I think you may have understated that. We – when we are looking at our term license revenue, a lot of that is driven off the prior year quarter, not the previous sequential quarter due to the contracts duration dynamics. So that’s a starting point to see what’s up of renewals and then, what comes from the add-ons and growth from the existing customers and then finally, trying to get some new business. So that’s the thought process as we goes through.

Got it. Helpful. And then, you mentioned a couple new virtual room customers. I think last quarter, you had signed your first virtual room customer, sort of couple are in pilots. So it’s good to see you might converted some of those who got some new customers. But you also said last quarter, you thought you are doing a product at about four times the pricing on a virtual room customer versus just a standard e-signature customer. Do you see that hold with a couple customers that you find this quarter with virtual room?

Yes, I think that is generally correct. I don’t have all of the exact pricing on those particular deals in my head. But, yes, we are looking at a premium for that product, which is good and we do have a few of those customers came off of trials since we spoken to them last and converted and that’s some of the examples we gave on the call here today.

And then, just lastly on hardware, are you able to quantify kind of what the headwind is in the quarter or was in the quarter? And do you expect most of that has been to be made up in Q4 or do you think the supply chain issues could potentially linger and dampen things during Q4?

I’ll let Jan Kees to take that.

Okay. I think, a little bit it has been look until Q4, but nothing really – there is a little bit of that variability in the quarter-to-quarter.

Yes, $1 million to $2 million, I would say is what got stuck in the boat and arrived. So, that should help us to get confirmation I believe.

Got it. That’s helpful. That’s it for me. I’ll jump back in the queue.

We currently have no further questions. I will now hand back over to the management team for any closing remarks.

Nothing for me here but just to say thank you to all of our OneSpan customers and employees around the world and of course, our investors that we work for every day. And if there is anything else, please follow-up with Joe Maxa and we can arrange a call and we can answer your questions directly and we look forward to the next time we are together.

This concludes today’s call. Thank you for joining and I hope you have a lovely rest of your day. You may now disconnect your lines.